India's updated CPI framework set to reduce inflation volatility, enhance policy precision: CEA Nageswaran

Chief Economic Advisor (CEA) Anantha Nageswaran (file image)

• India's new CPI series cuts food weight to reduce headline inflation volatility.
• Monetary and fiscal policy planning to become more predictable and stable
• Expanded rent measurement improves rural cost of living and poverty estimates

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Chief Economic Advisor V Anantha Nageswaran on Thursday outlined the significant improvements expected from India's new consumer price index (CPI) series, emphasizing its potential to transform both monetary and fiscal policy planning.

According to Nageswaran, the updated CPI framework establishes a stronger foundation for coordinating monetary and fiscal policy decisions. A key change, he informed, involves reducing the weightage assigned to the food and beverages category, which has historically contributed to substantial fluctuations in the headline inflation rate.

With food items carrying less weight in the overall index, Nageswaran anticipates that headline CPI will exhibit reduced volatility. This adjustment is expected to shift the primary drivers of inflation toward core components rather than food-related fluctuations.

"The monetary policy response in particular, could become more focused on aggregate demand pressures rather than dealing with supply-induced inflation, and dealing with it through a demand-sensitive variable like interest rates," he said.

The modified composition could fundamentally alter how monetary policy authorities respond to inflationary pressures. Nageswaran explained that policy responses may become more concentrated on aggregate demand pressures instead of attempting to address supply-induced inflation through demand-sensitive instruments such as interest rates.

The implications extend beyond monetary policy. Greater CPI stability promises to reduce volatility in fiscal expenditures tied to the inflation index, including dearness allowance calculations, inflation-indexed bonds, and similar mechanisms. This increased predictability could substantially improve budget planning and provide clearer visibility into fiscal projections.

"If CPI volatility declines, it means that fiscal expenditure volatility, such as DA fixation, inflation index, bonds, etcetera, which are linked to CPI, could also become more stable, predictable, and reliable. This could give better budget predictability and visibility to fiscal numbers as well," he added.

The new series also addresses geographic disparities in measurement accuracy. He said that by expanding rent measurement capabilities to rural areas and enhancing sampling coverage, the CPI now provides more precise housing cost data across different regions. This improvement reduces the urban bias that previously affected inflation estimates.

CEA stated, "By extending rent measurement to rural areas and improving sampling coverage, the CPI now captures housing costs more accurately across regions. This leads to a better measurement of the rural cost of living, reducing the urban bias in inflation estimation."

"As a result, poverty estimates become more accurate since real consumption and real income calculations depend directly on CPI," he summed up saying.